Nicholas Watson in Prague -

In a show of how seriously foreign investors are starting to take the economic progress of Central Asia and the Caucasus, the Scandinavian investment firm East Capital plans to launch a new fund next month dedicated to investing in what it describes as a "fascinating" region.

The East Capital Bering Central Asia Fund, which has a planned size of $100m, will invest in both private and listed companies in the 10 former Soviet states of the region, most of which are in the midst of a period of powerful economic growth thanks to high energy and other commodity prices.

"We like the region because we believe that all of them are developing in the right way, though definitely not at the same pace," says Karine Hirn, the CEO of East Capital.

Kazakhstan will be the focus of the fund, though that country's estimated GDP growth of 10.6% in 2006 pales in comparison with the 34.5% put in by Azerbaijan. However, Kazakhstan remains the richest country in the region with a gross national income (GNI) per capita in 2005 of $2,930, and has the most developed equity market with a total market capitalisation of $70bn.

To put that in perspective, that's twice the size of the market cap of Ukraine's stock market, in which the East Capital Bering Ukraine Fund has invested since July 2005. East Capital announced on January 11 that this fund had reached its $100m investment target and is now closed.

A mix of the public and private

Like all its offshore funds, the Central Asia fund will invest in private equity as well as listed companies. "We believe this is necessary because there's not that many companies listed," says Karine, adding that in the case of Kazakhstan there's also the option to invest in the growing number of companies listing on foreign exchanges such as London's. Kazakhstan's Halyk Savings Bank was the latest foreign firm to IPO, when it raised $680m in December.

In terms of private equity, East Capital typically looks for pre-IPO companies rather than those trying to raise venture capital, because the firm is primarily a financial investor as oppose to one that involves itself in the day-to-day running of companies.

"We look to buy stakes in companies where we find a lot of interesting things like good management, growing market share," says Hirn.

Sectors that the fund likes include banking, telecommunications and construction - parts of the economy benefiting from the trickle-down effect of the boom in raw materials and those areas unlikely to be targeted by capricious governments on a state-grab of assets. In the same vein, East Capital will underweight the oil and gas sector, which is the most at risk from such re-nationalisations. "Our Russia portfolio is 32% invested in oil and gas, which is much less than other investors and the index weighting," says Hirn.

There are, of course, other risks involved in investing in Central Asia and the Caucasus. One of the main differences between this region and Central and Eastern Europe is that there is no powerful external driver such as EU membership to drag the region forward.

Likewise, political risks are higher, with a preponderance of authoritarian regimes, though countries like Georgia have already undergone a democratic revolution, which makes them ideal places to invest. Even so, Hirn believes those quasi-democratic regimes like Kazakhstan and Azerbaijan could actually be pushed by the events in Georgia to press ahead with democratic reforms.

Corporate governance is also a major problem, though Hirn says this risks is probably not much greater than in Southeast Europe, where the fund manager invests through its East Capital Balkan Fund. (Contrary to recent press speculation, East Capital is not planning to start a fund dedicated to Romania, but plans to sell its funds more widely to Romanian investors.)

To overcome issues of corporate governance, East Capital will lean on its army of backroom staff of Russian speakers, who are able to keep the firm fully aware of developments in the companies in which it invests. "Close contact with the companies - that is key," says Hirn.

East Capital hopes to enjoy its first-mover advantage in these regional companies, most of which have never had a financial investor, let alone a foreign one.

"That's why there are so few investors in these places, because they're not easy markets to invest in. That's where our experience comes in - we know how to do this because we've been opening up markets like these for many years," says Hirn.

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